Public Information Notice: IMF Concludes 2001 Article IV Consultation with India

August 14, 2001

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

On June 20, 2001, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with India.1


India's macroeconomic performance during the 1990s was favorable. The economy recovered strongly from the 1991 balance of payments crisis and—despite the Asia crisis, international sanctions that followed the testing of nuclear devices in 1998, various natural disasters, and an oil shock—growth averaged nearly 6½ percent during the second half of the 1990s. During this period, conventional indicators of external vulnerability also improved. Moreover, recent data, which have shown a substantial improvement in many social indicators, including a significant reduction in the poverty rate, have provided encouraging evidence of the beneficial effects of growth and reform during the 1990s. Nonetheless, poverty reduction remains a significant policy challenge.

The growth rate of the economy has shown a decelerating trend in recent years. Overall GDP growth (at factor cost) had reached just over 6½ percent in 1998/99 (the fiscal year begins April 1), with a rebound in agricultural production and substantial fiscal stimulus. Growth slowed to under 6½ percent in 1999/00 and eased further to 5¾ percent (four-quarter basis) in the third quarter of 2000/01, owing to the waning effects of large civil service salary hikes in previous years, ongoing drought conditions in some states, and domestic energy price hikes in response to world oil market conditions. Business investment and confidence also have been adversely affected by infrastructure constraints, excess capacity, uncertainty regarding the effect of the elimination of quantitative import restrictions on competitiveness, and high real interest rates.

Recent data point to continued weakness, compounded by a devastating earthquake that struck the state of Gujarat in late January. The earthquake caused a massive loss of life, and damage to physical infrastructure is estimated as high as 1 percent of GDP. The region is an industrial center for the country, which may have contributed to the further decline in industrial production growth to 2¾ percent (year on year) in the first quarter of 2001. The continued sluggishness of the production of capital goods, vehicles, and textiles, as well as the sharp drop in loan growth also point to underlying weakness in domestic investment and consumer demand; a decline in cement production also indicates weak construction activity.

Abundant food stocks have mitigated the impact of energy price hikes on inflation. Wholesale price inflation, which peaked at 8½ percent (y/y) earlier this calendar year, declined to 5½ percent in April and May owing to the waning base effect of hikes in administered fuel prices—prices were raised in October 1999, and again in March and September 2000. Low agricultural price inflation has helped contain overall consumer prices, with CPI inflation decreasing to only 2¼ percent (y/y) in April 2001.

The current account deficit is estimated to have risen to just over 1 percent of GDP in 2000/01, as the effect of high world oil prices was partly offset by weak domestic demand and strong export growth. Although India is highly dependent on oil imports, which increased by 1¼ percent of GDP in the past year, the effect was offset by weak non-oil imports, especially of food and capital goods, and strong exports of garments, engineering goods, and refined petroleum products. Services receipts have also been robust, reflecting exports of IT-related services, and inward remittances from Indians abroad have been substantial.

However, pressures on the capital account mounted during 2000. Market confidence and portfolio inflows were undermined by the global turnaround in sentiment toward IT stocks (which represented roughly a quarter of India's market capitalization), concern about the impact of higher oil prices on the balance of payments, and fears that the rupee had lost competitiveness with the dollar's strength against other currencies. The Reserve Bank of India (RBI) responded to the pressure on the rupee by intervening heavily in spot and forward markets and by tightening domestic monetary conditions, hiking the Bank rate in July. Administrative restrictions on access to foreign exchange were also imposed, including one that was deemed in contravention of Article VIII. By end-October gross reserves had fallen by $3.2 billion to $34.9 billion (4¾ months of imports).

These pressures eased in late 2000 and into early 2001. The government's India Millennium Deposit (IMD) scheme—involving a five-year instrument marketed to nonresident Indians—yielded inflows of $5.5 billion in October and November 2000. The boost to reserves and the softening of world oil prices helped restore market confidence, and the cut in U.S. interest rates in early 2001 also helped strengthen the sentiment toward the rupee. In early 2001, the rupee/dollar rate had recovered some of its earlier losses, portfolio inflows had rebounded, and gross reserves reached $43 billion by early June (nearly 6 months of imports and four times short-term external debt).

With stronger exchange market conditions and signs of industrial weakening, monetary policy was eased. Money market conditions began to relax in late 2000, and bond yields fell sharply. The RBI subsequently moved to lower its Bank rate by 100 basis points in February/March, and reduced the commercial banks' cash reserve requirement by 50 basis points. Monetary policy was further eased in April and May, with two cuts of 25 basis points each of the RBI's repo rate, and a further 50 basis points reduction in the banks' cash reserve requirement.

However, financial market confidence remained fragile—although the stock market had recovered from the sharp losses suffered in early 2000, a stock market scandal, which involved accusations of insider trading and payment defaults by some brokers, and led to the closing of an urban cooperative bank, contributed to further declines and by end-April stock indices were roughly 40 percent off their early 2000 peak.

After widening markedly during the latter half of the 1990s, the public sector deficit is estimated to have fallen by ¾ percent of GDP in 2000/01 to 10½ percent of GDP. This is explained by adjustment at the state level—although consolidated data on their outturn is not yet available, their budgets aimed for substantial deficit reduction, mainly in response to increased transfers from the center. At the central government level, the deficit—defined by the staff to exclude privatization receipts—was roughly unchanged as a share of GDP, as tax shortfalls and higher-than-budgeted outlays for subsidies were more than offset by strong nontax revenues and a compression of capital and military outlays, relative to budget targets. Although delays in raising domestic fuel prices caused the deficit of the Oil Coordinating Committee to increase, this was offset by lower-than-expected capital outlays by public sector enterprises. The public sector debt ratio continued to rise, reaching 83 percent of GDP.

Against this background, the authorities recently established well-defined agendas for fiscal and structural reform. The Fiscal Responsibility and Budget Management Bill was tabled in parliament in late 2000, and would require deficit reduction by the central government of at least ½ percent of GDP a year and the achievement of a deficit of 2 percent of GDP by 2005/06. The legislation would also aim to improve fiscal discipline by enhancing transparency and requiring automatic expenditure cuts in the event of budget shortfalls. In addition, a broad set of proposals for second-generation reforms was released by the Prime Minister's Economic Advisory Council in January 2001. This proposed reform program would cover trade liberalization, the industrial and agricultural sectors, infrastructure, as well as fiscal and social policies. Effective April 1, 2001, India removed its remaining quantitative restrictions on imports, in line with WTO commitments, thus completing the process that began in the early 1990s.

The 2001/02 budget contained welcome commitments to structural reform, but emphasized growth rather than significant deficit reduction. In particular, the budget reiterated the government's commitment to lowering the central government deficit to 2 percent of GDP by 2005/06, in line with draft fiscal responsibility legislation, and endorsed a number of important structural initiatives. However, the 2001/02 deficit would remain roughly unchanged at about 5¼ percent of GDP, once divestment receipts were excluded from revenues. Although a broad range of tax cuts were introduced, these were assumed to be offset by tax buoyancy and increased compliance. A ¼ percent of GDP increase in capital expenditure also was largely matched by reductions in current expenditure.

Executive Board Assessment

Executive Directors commended the authorities for India's strong growth performance in recent years despite a series of adverse shocks, including the devastating earthquake in Gujarat and drought in parts of the country. Directors observed that India's economic strategy over the past decade had spurred growth, reduced poverty, and raised living standards. They especially welcomed recent plans to open up the economy further and address some of the deep-seated structural problems still facing India, as reflected in the draft fiscal responsibility legislation and the impressive blueprint for second-generation structural reforms.

Directors noted that the near-term outlook had become somewhat less favorable. Although the external position appeared comfortable, and inflation pressures had waned, growth had slowed in recent years and the global slowdown may have further adverse implications. Moreover, in addition to external shocks, there were continued signs that domestic structural constraints and the fiscal situation were adversely affecting investment and the economy's underlying potential.

Directors agreed that reversing the recent decline in growth and sustaining rapid progress toward poverty alleviation, as well as maintaining the momentum and support for reform, would require determined implementation of the authorities' policy agenda. In particular, ambitious fiscal consolidation and broad-based structural reforms were needed to allow resources to be redirected from servicing public debt toward development and social programs, and to provide room and encouragement for private investment.

Looking ahead, Directors noted that the overall public sector deficit and debt appeared likely to remain high in 2001/02. Although the central government's budget had contained impressive commitments to reform, the slowdown in economic activity, revenue shortfalls in recent months, and expenditure pressures, including those related to bank restructuring and civil service reform, posed significant challenges in meeting the target. The states' fiscal situation also remained worrisome, especially given the reconstruction costs in Gujarat and difficulties in the power sector.

Therefore, the critical priority in the period ahead remained to place the fiscal position on a sustainable path. Directors broadly endorsed the objectives of the proposed fiscal responsibility legislation, which would establish a clearly-defined timetable for lowering the central government deficit, and called on the authorities to press for prompt passage and for strict implementation following enactment into law. Similar adjustment at the state level would go a long way to reduce the overall public sector deficit ratio and place the debt ratio on a firm downward path.

Directors stressed that fiscal discipline and transparency would be essential for year-to-year adherence to the legislation's fiscal targets. Improvements to the budget framework and accounting rules—along the lines contained in the draft legislation—would be particularly helpful. It would also be important to ensure that the legislation's longer-term fiscal targets, flexibility provisions, and enforcement mechanisms were specified in a manner that ensured the legislation's credibility and durability.

Directors welcomed the steps taken in the 2001/02 budget toward expenditure rationalization. In this regard, they called for the early adoption of the recommendations of the Expenditure Reforms Commission and the Prime Minister's Economic Advisory Council, in particular for cutting fiscal subsidies, improving the delivery and targeting of poverty reduction programs, downsizing government, and increasing the efficiency of plan spending.

Directors stressed that a significant increase in the revenue ratio would be an essential prerequisite to successful fiscal consolidation. Given the authorities' commendable commitment to lowering customs tariff rates, Directors cautioned that significant offsetting measures would be required to achieve the needed increase in the revenue ratio, and suggested that the emphasis should be placed on eliminating exemptions on income and excise taxes. Some Directors pointed to the importance of bringing the agricultural sector more fully under the tax net.

Directors encouraged the authorities to continue their efforts to promote fiscal reform at the state level, including through the new fiscal reform facility. These efforts would need to be backed by a hardening of state budget constraints and by promoting fiscal responsibility legislation at the state level. Directors underscored the importance of ensuring that the design and administration of planned state-level value-added taxes were strong enough to maintain or enhance revenues.

With regard to monetary policy, Directors agreed that the recent easing by the Reserve Bank of India appeared appropriate, given signs of slowing activity and indications that underlying inflation pressures remained moderate. They also acknowledged that the more recent reductions in international interest rates and signs that domestic demand remained weak meant that there might be further room for easing. However, Directors cautioned that the large public sector borrowing requirement narrowed the scope for reducing interest rates without undermining the credibility of the authorities' commitment to price stability. In this context, a few Directors highlighted the suggestion of the advisory group on monetary policy transparency for the establishment of a more explicit medium-term inflation objective.

Directors generally agreed that the rupee appeared broadly in line with present macroeconomic fundamentals but, in the period ahead, the exchange rate might need to adjust to the effects of capital account and trade liberalization, domestic deregulation, fiscal consolidation, and a more difficult external environment. In this context, while a number of Directors noted that the authorities' policy of intervention to counter disorderly exchange market conditions had served the economy well and had helped to promote broader macroeconomic stability, other Directors cautioned that market forces should be given freer play in order to provide adequate incentives for risk management and allow smoother adjustments to changing circumstances. These Directors cautioned against the authorities' use of administrative measures to stabilize the rate, and emphasized the importance of measures to further deepen the foreign exchange market.

Directors suggested that recent developments had illustrated the importance of determined and consistent progress in the area of financial sector reform. While they appreciated the authorities' effective response to the recent stock market scandal, the incident had exposed significant weaknesses in supervisory and regulatory systems, and called for a strengthening of payments and settlement systems and improvements in governance. An efficient financial system was also essential to support India's broader development needs, and Directors strongly encouraged the authorities to allow a greater role for the private sector in the banking sector, further strengthen mechanisms to deal with non-performing loans, and more generally follow up on the recommendations of the Financial System Stability Assessment.

Turning to structural policies, Directors emphasized the importance of implementing reforms along the lines laid out by the Economic Advisory Council. Power sector reform was a particular priority, given the sector's important macroeconomic and fiscal implications, and would need to include tariff increases for agricultural consumers and measures to reduce theft and other distribution losses. At the same time, however, they stressed that measures to improve productivity and growth in the industrial sector were also essential, and should include reform of bankruptcy legislation, reform of policies governing the small-scale sector, privatization of government enterprises, and liberalization of labor laws in order to improve competitiveness. Directors stressed that additional measures to attract foreign direct investment would help increase growth, including continued efforts to streamline administrative procedures and regulations. In the agricultural sector, they urged implementation of measures to ease restrictions on the trade and movement of agricultural commodities, sharply reduce the role of government procurement agencies, and improve cost recovery.

Directors welcomed the government's emphasis on establishing safety nets to ease adjustment, as well as on reforming and extending the old-age security system. However, they cautioned that it would be important to ensure that these new systems were designed in a manner that did not undermine efficiency or the goal of fiscal sustainability.

Directors were encouraged by steps taken toward capital account and trade liberalization during the past year, especially the removal of quantitative restrictions on imports. Looking ahead, they added that it would be important to carry forward the commitment to reducing customs duties in a timely manner, while ensuring that the potential gains from trade liberalization were not undermined by overuse of offsetting measures. Directors welcomed the recent withdrawal of the surcharge on import financing, which had been in contravention of Article VIII, and encouraged the authorities to eliminate remaining payments restrictions as soon as possible. A number of Directors added that countries like India would benefit significantly from multilateral trade liberalization, and called on industrial countries to improve market access for developing country exports, especially in textiles, agriculture, and services.

Directors acknowledged India's active participation in the international effort to promote standards and codes. At the same time, however, India's macroeconomic and fiscal data continued to suffer from weaknesses that undermined economic analysis and policy making. Directors, therefore, urged the authorities to continue to address these shortcomings in the period ahead, including possibly through a Statistics Report on the Observance of Standards and Codes.

India: Selected Economic Indicators 1/

  1997/98 1998/99 1999/00 2000/01  

  Percentage change
Domestic economy          
Real GDP at factor cost 4.8 6.6 6.4 5.8 2/
Industrial production 6.6 4.1 6.6 5.0  
Wholesale prices 4.3 6.0 3.4 7.1  
Consumer prices 6.8 13.1 3.4 3.8  
  In billions of U.S. dollars
External economy          
Merchandise exports 35.7 34.3 38.3 45.1 2/
Merchandise imports 51.2 47.5 55.4 63.1 2/
Current account balance -5.5 -4.0 -4.2 -5.2 2/
(In percent of GDP) -1.3 -1.0 -0.9 -1.1 2/
Direct investment, net 3/ 3.5 2.4 2.1 2.1 2/
Portfolio investment, net 1.8 -0.1 3.0 2.4 2/
Capital account balance 9.8 8.6 10.2 11.4 2/
Gross official reserves 4/ 29.4 32.5 38.0 42.3  
(In months of imports) 5/ 6.0 5.8 5.9 5.9  
External debt (in percent of GDP) 4/ 22.8 23.4 21.8 22.2 2/
Short-term debt (in percent of GDP) 4/ 6/ 2.9 2.7 2.2 2.3 2/
Debt service ratio (in percent of current receipts) 19.3 19.3 17.8 14.5 2/
Change in real effective exchange rate (in percent) 4/ 5.6 -6.2 1.1 6.2 2/
  In percent
Financial variables          
Central government balance (in percent of GDP) 7/ -4.9 -5.4 -5.4 -5.4 2/
Consolidated public sector balance (in percent
of GDP) 7/
-8.5 -9.6 -11.2 -10.4 2/
Change in broad money 4/ 18.0 19.2 13.6 17.4  
Interest rate 4/ 8/ 7.3 8.7 9.2 8.8  

Sources: International Financial Statistics; Reserve Bank of India; Ministry of Finance; CEIC; and IMF staff estimates.

1/ Data are for April-March fiscal years, and are those that were available at the time of the Board meeting.  
2/ Staff estimates as of June 2001.          
3/ Net foreign direct investment in India less net foreign investment abroad.      
4/ End of period.          
5/ Imports of goods and services projected over the following twelve months.
6/ Residual maturity basis, except contracted maturity basis for medium- and long-term nonresident Indian accounts.
7/ Excluding divestment receipts from revenues and onlending of small saving collections from expenditures and net lending.
8/ 91-day Treasury Bill rate.          

1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. This PIN summarizes the views of the Executive Board as expressed during the June 20, 2001 Executive Board discussion based on the staff report.


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